When to Seek Financing for a Business Acquisition
Mid-Market Lending Insights
A shut-down in some business operations due to COVID-19 restrictions also caused many acquisitions to go on hold until buyers could understand the full impact of closures on the financial outlook of the target business.
With business reopenings in the late summer and fall, there is increasing interest from dealmakers, including private equity firms, independent sponsors and existing business owners in pursuing mid-market acquisitions. Buyers who are able to get financing are taking advantage of sharply depressed target company valuations that are still down due to ongoing economic volatility. This presents a compelling opportunity for buyers who can access financing to take advantage of temporary depressions in business valuations to increase their portfolio.
Experienced buyers know that acquisition targets that can support larger debt amounts will require less cash equity to purchase. While many buyers would like to get a loan pre-approved before engaging sellers, corporate lenders prefer to work in reverse. In order to receive term sheets and ultimately pass a credit committee, borrowers will often need to identify a specific target company and will need to begin at least preliminary negotiations with the sellers.
Lenders regularly receive applications for acquisition financing and they know well that M&A deals fall apart all the time for any number of reasons. The more serious the buyer is about the deal, and the more the buyer can eliminate unknowns, the more interested lenders will be in supporting your acquisition loan request.
So, when is the right time to engage lenders for a potential business acquisition?
Identify a specific acquisition target first
Narrow down your search from a general company profile to a specific company target that you would like to purchase. If you are an individual or group of investors, make sure you and the management team have experience in the industry and/or experience growing a similar business model. If your existing company wants to merge or acquire another company, ensure there are clearly outlined synergies that make the two companies better together than on their own. In both cases, lenders will ultimately want to hear why this specific target was selected over other companies. While business brokers are an easy way to identify companies for sale, remember that there are likely other buyers knocking at their door with offers which will create more risk for you and lenders. .
Get detailed financial information from your target
In the course of your evaluation, the target company will need to provide you with financial performance from previous years, as well as the current year, along with any projections and models of future performance. During your own due diligence, you will also want to understand the ownership structure, existing debts, any legal concerns, including outstanding lawsuits, and customer relationships. The target will likely ask you to sign an NDA but otherwise should be willing to provide this information if they are serious about selling the business. Finally, they should provide you with a proposed sale price which indicates how much they believe the business is worth.
Estimate your loan terms
After you’ve identified your target company,received company financials and sale price documents, you can start estimating your loan size and interest rate. You can do this by calling lenders one by one, completing multiple applications, and waiting for calls back or you can use Cerebro’s complimentary loan assessment tool which takes about 15 minutes to complete. Not only does the tool save you time, it also ensures you are considering all your loan options across the whole market of conventional loans, government-backed programs and non-bank loans. Often individual bankers can only evaluate your loan request under one or two structures. To avoid false negatives, leverage Cerebro’s platform to aggregate data from over 800 commercial bank and non-bank lenders.
Understand your cash position
In today’s environment, it is very difficult to secure a corporate loan for an acquisition without putting cash down toward the purchase price. This is true for both individuals and companies who are acquiring middle and lower-middle market companies. Many times the sellers are willing to offer a seller note or retain equity, but neither will replace the importance of having new cash equity from the buyers.
The amount of cash needed will ultimately depend on the type of lender, type of loan and profile of the companies, but 10-20% new cash is a fairly common threshold for acquisition deals. This means if you only have access to $200,000, buying a company for more than $2 million is probably a reach. With Cerebro’s loan analysis, you will have a better understanding of how much potential cash you will need to bring to the table.
Negotiate an exclusive LOI with the seller
Once you have determined that the business has passed your initial diligence, and you’re likely to receive a loan based on the company profile, your next step is to secure an exclusive letter of intent (LOI) to acquire the business. Your LOI should include the proposed price and high level terms for the acquisition including what assets are or are not included in the sale and how much the seller might be willing to finance. It is typically drafted as a non-binding agreement. Without exclusivity, you run the risk of the sellers entertaining other offers and lenders dragging their feet waiting to see if the deal is really moving forward.
Launch a formal loan request and engage lenders
With a signed, exclusive LOI and access to the target’s financial package, you are now ready to complete a detailed loan application and engage lenders. Lenders might have specific questions about the target’s performance, financial statements, competitors, customers, etc. So you should keep an open dialogue with the sellers throughout this period to obtain all lender requested materials. Buyers with a signed LOI are likely to get more attention from lenders as they view the deal more likely to proceed than an acquisition without an LOI.
Keep in mind that banks will often signal their willingness to move forward, but their interest should be taken with a grain of salt until they provide a written term sheet that has been approved by their credit committee. It might take anywhere from a few days to a few weeks to receive a written term sheet, but it will ultimately indicate to the seller your ability to finance the transaction and the seriousness of your offer.
Due to the lengthy process involved in reaching the term sheet stage of a debt deal, it’s important to have partners that can help you expedite the process. Involving your accounting and legal partners, as well as assessing your existing finances, including available cash, is important to ensure you can execute the transaction before other buyers come to the table.
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